Regulations Issued on Treasury Inflation-Protected Securities Issued at a Premium

Published January 09, 2013

The IRS has issued final regulations on the tax treatment of Treasury Inflation-Protected Securities (TIPS) that have more than a de minimis amount of premium, and temporary and proposed regulations on debt instruments with bond premium carryforward in the holder’s final accrual period (T.D. 9609; REG-140437-12). The final regulations adopt proposed regulations (REG-130777-11) that were issued in 2011.

Final regs. on TIPS

TIPS are securities issued by the Treasury Department; the principal amount of a TIPS is adjusted for inflation or deflation that occurs over the term of the security. Before 2011, no TIPS had been issued with more than a de minimis amount of premium (that is, an amount greater than 0.0025 times the stated principal amount of the security times the number of complete years to the security’s maturity). However, anticipating that TIPS might be issued with more than a de minimis amount of premium, the IRS announced in 2011 that regulations would be issued to provide guidance in that situation (Notice 2011-21).

The new final regulations provide that taxpayers must use the coupon bond method described in Regs. Sec. 1.1275-7(d) for a TIPS that is issued with more than a de minimis amount of premium. The final regulations include an example illustrating how to apply the coupon bond method to a TIPS issued with more than a de minimis amount of premium and a negative yield. As stated in Notice 2011-21, the final regulations apply to TIPS issued on or after April 8, 2011.

Bond premium carryforward

The IRS has received questions about the holder’s treatment of a taxable zero coupon debt instrument, including a Treasury bill, acquired at a premium and a negative yield. Under Regs. Secs. 1.171-2 and 1.1016-5(b), a holder that elected to amortize the bond premium generally would have a capital loss upon the sale, retirement, or other disposition of the debt instrument rather than an ordinary deduction under Sec. 171(a)(1) for all or a portion of the bond premium. The IRS says this situation, which has arisen as a result of recent market conditions, was not contemplated when the current regulations were adopted in 1997. The new temporary and proposed regulations address this issue by adding a specific rule for the treatment of a bond premium carryforward determined as of the end of the holder’s final accrual period for any taxable bond for which the holder has elected to amortize bond premium.